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© 2006 Brian F. Schreurs
Even we have a disclaimer.

Except, of course, all you're really doing is getting back your own money! Which the government has borrowed all year without paying you one cent in interest!

Let's take a step back and look at the tax system for a moment. The government has asked that we surrender a percentage of our income to keep the bureaucracy running. We have agreed to that. But, the government, realizing that very few people have the fiscal discipline to set aside a third of their income to pay taxes at the end of each year, has implemented a clever plan wherein our employer actually does the bulk of the tax collecting by withholding it from our paycheck and turning it in for us. If you were to ask your employer to stop withholding taxes, so that you could just pay them at the end of the year and invest the money in the meantime, the answer would be "no". This plan is not optional.

In essence, the government is forcibly borrowing your money over the course of the year. Not only that, but they're not paying you any interest either. Even a lousy savings account is worth a percentage or two, but not the IRS. Nothing! The only good news out of this is that you have some control over how much the government borrows from you by making adjustments to your W-4 form.

So the goal should be to minimize the amount of money that the government takes out of your paycheck, and pay the balance of your taxes at the end of the year when they're actually due. But, the IRS doesn't like that very much, and the regulations are written so that you get in trouble and have to pay penalties if you owe more than $1000 -- even though you're not actually late. Therefore, the best we can really hope for is to owe a few hundred dollars at the end of the year, perhaps $200 or $300, maybe even $500. Much more than that and you run the risk of a miscalculation throwing you over the $1000 bad-day threshold.

Which is a long way around of saying that, if your tax preparer (or tax software) gets you a big fat refund at the end of the year, then your reaction should be less "Wooohooo! We won! We're going to Disney World!" and more "What the heck?! Who screwed up our tax planning last year to cause this fiasco?!"

Someone who gets a $1000 refund instead of owing $500 has lost the use of $1500 for 12 months -- $125 per month. Money that could have been put toward a car payment, or groceries, or day care, or an investment. Even better, that's money that could have been invested in a pretax retirement plan: not only putting the money to work and earning a return, but also further reducing taxable income! Anyone who promises to get you a huge refund is, in essence, promising to help Uncle Sam rip you off.

A more honest tax preparer, on your first visit, might say something more like "Well, it's too late to fix this year's return, but we'll help you get this sorted out so that you keep control of your money next year." Then, working with this responsible person, you'll find ways to free up extra disposable income or find yourself investing for retirement without even noticing it -- instead of loaning it to the feds for free, you'll be investing in your future.

Let's run some numbers. Let's say you typically get a $1000 refund. Now you want to get smart, and instead of getting a refund, owe the government $500. So you adjust your W-4 to withhold $1500 less than before. But then you also join your company's 401(k) plan for the amount of $1500/year, thereby reducing your taxable income by the same amount. If you pay 15% in taxes, then your tax bill will be $225 lower than it was. At the end of the year you could enjoy having earned interest on your investment (probably about $100 or so, based on the S&P 500 30-year average) and owe only $275 in taxes, or you could stick to your $500 tax target and up your retirement contribution to $1825, earning a few extra bucks along the way. Keep this up for a decade, and thanks to the magic of compounding, this change of attitude toward tax planning would give you a retirement investment of $32,000, instead of the $10,000 worth of refunds you might have frittered away.

Hey, if you don't want an extra $22,000 over ten years, that's fine. Let the government borrow your money interest-free.

But for those who want to make the right choice, not necessarily just taking the easy way, the advantage of only paying what you owe to the system is self-evident. For those people, the blockhead advertisements -- especially the ones that promise to loan you your own money -- will become flat-out appalling.